An investigation by the International Consortium of Investigative Journalists has revealed how more than 1000 businesses from 340 major companies from around the world have used Luxembourg as a base for avoiding huge amounts of tax. Many of the companies are household names, such as Ikea, FedEx, Apple, Pepsi, Coca Cola, Dyson, Amazon, Fiat, Google, Accenture, Burberry, Procter & Gamble, Heinz, JP Morgan, Caterpillar, Deutsche Bank and Starbucks. Through complicated systems of ‘advanced tax agreements’ (ATAs), negotiated with the Luxembourg authorities via accountants PricewaterhouseCoopers (PwC), companies have used various methods of avoiding tax.
Although such measures are legal, they have denied other countries vast amounts of tax revenues on sales generated in their own countries. Instead, the much reduced tax bills have been paid to Luxembourg. The result is that this tiny country, with a population of just 550,000, has, according to the IMF, the highest (nominal) GDP per head in the world (estimated to be $116,752 in 2014).
So what methods do Luxembourg and these multinational companies use to reduce the companies’ tax bills? There are three main methods. All involve having a subsidiary based in Luxembourg: often little more than a small office with one employee, a telephone and a bank account. All involve varieties of transfer pricing: setting prices that the company charges itself in transactions between a subsidiary in Luxembourg and divisions in other countrries.
The first method is the use of internal loans. Companies lend money to themselves, say in the UK, from Luxembourg at high interest rates. The loan interest can be offset against profit in the UK, reducing tax liability to the UK tax authorities. But the interest earned by the Luxembourg subsidiary incurs very low taxes. Profits are thus effectively transferred from the UK to Luxembourg and a much lower tax bill is incurred.
The second involves royalty payments for the use of the company’s brands. These are owned by the Luxembourg subsidiary and the overseas divisions pay the Luxembourg subsidiary large sums for using the logos, designs and brand names. Thus, again, profits are transferred to Luxembourg, where there is a generous tax exemption.
The third involves generous allowances in Luxembourg for losses in the value of investments, even without the company having first to sell the investments. These losses can be offset against future profits, again reducing tax liability. By transferring losses made elsewhere to Luxembourg, again usually by some form of transfer pricing, these can be used to reduce the already small tax bill in Luxembourg even further.
Tax loopholes offered by tax havens, such as Luxembourg, the Cayman Islands and the Channel Islands, are denying exchequers around the world vast sums. Not surprisingly, countries, especially those with large deficits, are concerned to address the issue of tax avoidance by multinationals. This is one item on the agenda of the G20 meeting in Brisbane from the 12 to 16 November 2014.
The problem, however, is that, with countries seeking to attract multinational investment and to gain tax revenues from them, there is an incentive to reduce corporate tax rates. Getting any binding agreement on tax harmonisation, and creating an essentially global single market, is likely, therefore, to prove virtually impossible.
Webcasts and videos
Luxembourg Leaks: Tricks of the Trade ICIJ in partnership with the Pulitzer Center (5/11/14)
Luxembourg ‘abetted’ companies in avoiding taxes France 24, Siobhán Silke (6/11/14)
Tax deals with Luxembourg save companies billions, says report Deutsche Welle, Dagmar Zindel (6/11/14)
Luxembourg: the tax haven and the $870m loan company above a stamp shop The Guardian, John Domokos, Rupert Neate and Simon Bowers (5/11/14)
Luxembourg leaks: nation under spotlight over tax avoidance claims euronews (6/11/14)
Northern and Shell used west Dublin address to cut Luxembourg tax bill on €1bn The Irish Times, Colm Keena (6/11/14)
The ATO’s global tax avoidance investigation ABC News, Phillip Lasker (9/11/14)
Pepsi, IKEA Secret Luxembourg Tax Deals Exposed TheLipTV, Elliot Hill (9/11/14)
Articles
Leaked Docs Expose More Than 340 Companies’ Tax Schemes In Luxembourg Huffington Post, Leslie Wayne, Kelly Carr, Marina Walker Guevara, Mar Cabra and Michael Hudson (5/11/14)
Luxembourg tax files: how tiny state rubber-stamped tax avoidance on an industrial scale The Guardian, Simon Bowers (5/11/14)
Fact and fiction blur in tales of tax avoidance The Guardian (9/11/14)
companies engaged in tax avoidance The Guardian, Michael Safi (6/11/14)
The Guardian view on tax avoidance: Europe must take Luxembourg to task The Guardian, Editorial (6/11/14)
G20 leaders in the mood to act on tax avoidance after Luxembourg leaks Sydney Morning Herald, Tom Allard (6/11/14)
Scale of Luxembourg tax avoidance revealed economia, Oliver Griffin (6/11/14)
EU to press Luxembourg over tax breaks amid fresh allegations BBC News (6/11/14)
Luxembourg leaks: G20 alone can’t stamp out tax avoidance The Conversation, Charles Sampford (7/11/14)
‘Lux leaks’ scandal shows why tax avoidance is a bad idea European Voice, Paige Morrow (8/11/14)
EU to Probe Luxembourg’s ‘Sweetheart Tax Deal’ with Amazon International Business Times, Jerin Mathew (7/10/14)
Investigative Project
Luxembourg Leaks: Global Companies’ Secrets Exposed The International Consortium of Investigative Journalists (5/11/14)
Questions
- Distinguish between tax avoidance and tax evasion. Which of the two is being practised by companies in their arrangements with Luxembourg?
- Explain what is meant by transfer pricing.
- Do a search of companies to find out what parts of their operations as based in Luxembourg.
- In what sense can the setting of corporate taxes be seen as a prisoner’s dilemma game between countries?
- Discuss the merits of changing corporate taxes so that they are based on revenues earned in a country rather than on profits.
- What type of agreement on tax havens is likely to be achieved by the international community?
- Is it desirable for companies to be able to offset losses against future profits?
The spectre of debt has awoken many of us in the night. Indebtedness is a key economic issue in the 2010s. Economists are devoting ever increasing amounts of research time trying to understand its impact on economic behaviour. This will not surprise you when you learn that the debt owed by the UK non-bank private sector to banks stood at £2.17 trillion at the end of September. This is the equivalent to 150% of annual GDP.
Chart 1 shows the stock of outstanding lending by Monetary Financial Institutions (banks and building societies) to the non-bank private sector bank since 1979. Back then the non-bank private sector had bank debt to the tune of around £70 billion or 10 per cent of GDP. Today’s figure is nearly 3000 per cent higher! Of this debt, around about 55 per cent is currently held by the household sector, 27 per cent by Other Financial Corporations (such as insurance companies and pension funds) and 18 per cent by private non-financial corporations. (Click here for a PowerPoint of the chart.)
Chart 2 shows the stocks of debt as percentages of annual GDP. We can infer from it that there are waves of growth in bank debt. Two notable periods are during the 1980s and again from the late 1990s up to the financial crisis of the late 2000s. During the early and mid 1990s the relative size of debt stocks tended to stabilise while in the early 2010s the actual stocks of debt, as well as relative to GDP, declined. A credit binge seems to be followed by a period of consolidation. (Click here for a PowerPoint of the chart.)
It is important that we understand the drivers of the growth of debt. The impact of debt on the balance sheets of the non-bank private sector and on banks themselves has implications for economic behaviour. In the early 2010s this has been to markedly slow the pace of growth through its impact on aggregate demand. Economic agents have, in general, looked to consolidate. There is no doubt that this partly reflects a precautionary motive. An important means by which debt and the balance sheets on which it is recorded affect behaviour is through a precautionary mechanism. This is difficult to accurately quantify because it represents a psychological influence on spending. Furthermore, it is affected by the prevailing circumstances of the time.
In looking to understand the factors that affect the growth of debt we may, as a result, learn more about the framework within which we may want banks and their customers to operate. Consequently, we may be in a better position to ensure sustainable longer-term growth and development. If there are cycles in credit it is important that we understand why they arise and whether, as some have suggested, they are an inherent part of the financialised economy in which we live. If they are, can we mitigate their potentially destabilising effects?
Articles
Retail shares facing nightmare before Christmas The Telegraph, John Ficenec (9/11/14)
Growing wealth inequality in the UK is a ticking timebomb The Guardian, Danny Dorling (15/10/14)
Richest 10% of Britons now control more than half the country’s wealth: Nation is only member of G7 where inequality between rich and poor has increased this century Mail Online, Mark Duell and Corey Charlton, (15/11/14)
Household debt is growing as families struggle Yorkshire Evening Post (31/10/14)
Consumer spending forecast to be the highest for four years The Telegraph, Ashley Armstrong (10/11/14)
Data
Statistical Interactive Database Bank of England
Quarterly National Accounts, Q2 2014 Dataset Office for National Statistics
Questions
- What is the non-bank private sector?
- What factors might affect the rate at which non-bank private sector debt stocks grow?
- How might we go about assessing whether the aggregate level of lending by financial institutions to the non-bank private sector is sustainable?
- How might we go about assessing whether the level of lending by individual financial institutions to the non-bank private sector is sustainable?
- What information is conveyed in the balance sheets of economic agents, such as households and private non-financial corporations
- What is meant by precautionary saving?
- Can precautionary saving occur when the economy is growing strongly?
- What are the mechanisms by which non-bank private sector debt could impact on economic behaviour?
Following the recession of 2008/9, the UK has engaged in four rounds of quantitative easing (QE) – the process whereby the central bank increases the money supply by purchasing government bonds, and possibly other assets, on the open market from various institutions. The final round was announced in July 2012, bringing the total assets purchased to £375bn. As yet, however, there are no plans for quantitative tightening – the process of the Bank of England selling some of these assets, thereby reducing money supply.
The aim of QE has been to stimulate aggregate demand. Critics claim, however, that the effect on spending has been limited, since the money has not gone directly to consumers but rather to the institutions selling the assets, who have used much of the money to buy shares, bonds and other assets. Nevertheless, with banks having to strengthen their capital base following the financial crisis, QE has helped then to achieve this without having to make even bigger reductions in lending.
The Bank of England now reckons that the recovery is sufficiently established and there is, therefore, no need for further QE.
This is also the judgement of the Federal Reserve about the US economy, which experienced annual growth of 3.5% in the third quarter of 2014. The IMF predicts that US growth will be around 3% for the next three years.
The Fed has had three rounds of QE since the financial crisis, but in October 2014 called an end to the process. Since the start of this year, it has been gradually reducing the amount it injects each month from $85bn to $15bn. The total bond purchases over the past five years have been some $3.6tn, bringing the Fed’s balance sheet to nearly $4.5tn.
But as QE comes to an end in the USA, Japan is expanding its programme. On 31 October, the Bank of Japan announced that it would increase its asset purchases from ¥60-70tn per year to ¥80tn (£440bn). The Japanese government and central bank are determined to boost economic growth in Japan and escape the two decades of deflation and stagnation. The Tokyo stock market rose by some 8% in the week following the announcement and the yen fell by more than 5% against the dollar.
And the European Central Bank, which has not used full QE up to now, looks as if it is moving in that direction. 
In October, it began a programme of buying asset-backed securities (ABSs) and covered bonds (CBs). These are both private-sector securities: ABSs are claims against non-financial companies in the eurozone and CBs are issued by eurozone banks and other financial institutions.
It now looks as if the ECB might take the final step of purchasing government bonds. This is probably what is implied by ECB President Mario Draghi’s statement after the 6 November meeting of the ECB that the ground was being prepared for “further measures to be implemented, if needed”.
But has QE been as successful as its proponents would claim? Is it the solution now to a languishing eurozone economy? The following articles look at these questions.
Fed calls time on QE in the US – charts and analysis The Guardian, Angela Monaghan (29/10/14)
Quantitative easing: giving cash to the public would have been more effective The Guardian, Larry Elliott (29/10/14)
End of QE is whimper not bang BBC News, Robert Peston (29/10/14)
Federal Reserve ends QE The Telegraph, Katherine Rushton (29/10/14)
Bank of Japan to inject 80 trillion yen into its economy The Guardian, Angela Monaghan and Graeme Wearden (31/10/14)
Every man for himself The Economist, Buttonwood column (8/11/14)
Why Japan Surprised the World with its Quantitative Easing Announcement Townhall, Nicholas Vardy (7/11/14)
Bank of Japan QE “Treat” Is a Massive Global Trick Money Morning, Shah Gilani (31/10/14)
ECB stimulus may lack desired scale, QE an option – sources Reuters, Paul Carrel and John O’Donnell (27/10/14)
ECB door remains open to quantitative easing despite doubts over impact Reuters, Eva Taylor and Paul Taylor (9/11/14)
ECB could pump €1tn into eurozone in fresh round of quantitative easing The Guardian,
Angela Monaghan and Phillip Inman (6/11/14)
Ben Bernanke: Quantitative easing will be difficult for the ECB CNBC, Jeff Cox (5/11/14)
Not All QE Is Created Equal as U.S. Outpunches ECB-BOJ Bloomberg, Simon Kennedy (6/11/14)
A QE proposal for Europe’s crisis The Economist, Yanis Varoufakis (7/11/14)
UK, Japan and 1% inflation BBC News, Linda Yueh (12/11/14)
Greenspan Sees Turmoil Ahead As QE Market Boost Unwinds Bloomberg TV, Gillian Tett interviews Alan Greenspan (29/10/14)
Questions
- What is the transmission mechanism between central bank purchases of assets and aggregate demand?
- Under what circumstances might the effect of a given amount of QE on aggregate demand be relatively small?
- What dangers are associated with QE?
- What determines the likely effect on inflation of QE?
- What has been the effect of QE in developed countries on the economies of developing countries? Has this been desirable for the global economy?
- Have businesses benefited from QE? If so, how? If not, why not?
- What has been the effect of QE on the housing market (a) in the USA; (b) in the UK?
- Why has QE not been ‘proper’ money creation?
- What effect has QE had on credit creation? How and why has it differed between the USA and UK?
- Why did the announcement of further QE by the Bank of Japan lead to a depreciation of the yen? What effect is this depreciation likely to have?
A big expenditure for many households is petrol. The price of petrol is affected by various factors, but the key determinant is what happens in the oil market. When oil prices rise, this pushes up the price of petrol at the pumps. But, when they fall, do petrol prices also fall? That is the question the government is asking.
The price of oil is a key cost of production for companies providing petrol and so when oil prices rise, it shifts the supply curve up to the left and hence prices begin to increase. We also see supply issues developing with political turmoil, fears of war and disruption and they have a similar effect. As such, it is unsurprising that petrol prices rise with concern of supply and rising costs. But, what happens when the opposite occurs? Oil prices have fallen significantly: by a quarter. Yet, prices at the pump have fallen by around 6%. This has caused anger amongst customers and the government is now urging petrol retailers to pass their cost savings from a lower price of oil onto customers. Danny Alexander, Chief Secretary to the Treasury said:
“I believe it’s called the rocket-and-feather effect. The public have a suspicion that when the price of oil rises, pump prices go up like a rocket. But when the price of oil falls, pump prices drift down like a feather … This has been investigated before and no conclusive evidence was found. But even if there were a suspicion it could be true this time it would be an outrage.”
However, critics suggest that tax policy is partly to blame as 63% of the cost of petrol is in the form taxation through fuel duty and VAT. Therefore even if oil prices do fall, the bulk of the price we pay at the pumps is made up of tax revenue for the government. Professor Stephen Glaister, director of the RAC Foundation said:
“It’s a simple story. Before tax we have just about the cheapest petrol and diesel in Europe. After tax we have just about the most expensive … It’s right to keep the pressure on fuel retailers but if drivers want to know what’s behind the high pump prices of recent years all they have to do is follow the trail back to the Treasury … if ministers are serious about reducing fuel prices further then they should cut duty further.”
(Click here for a PowerPoint of the chart.)
However, even taking out the fuel duty and VAT, Arthur Renshaw, an analyst at Experian has said that the actual price of petrol has fallen by 21% since last year. Still, a much bigger decrease than we have seen at the pumps. One further reason for this may be the fact that dollars is the currency in which oil is traded. The pound has been relatively weak, falling by almost 7% over the past few months and hence even though the price of oil has fallen, the effect on UK consumers has been less pronounced.
The big supermarkets have responded to government calls to cut petrol prices, but how much of this cut was influenced by the government and how much was influenced by the actions of the other supermarkets is another story. A typical oligopoly, where interdependence is key, price wars are a constant feature, so even if one supermarket cut petrol prices, this would force others to respond in kind. If such price wars continue, further price cuts may emerge. Furthermore, with oil production still at such high levels, this market may continue to put downward pressure on petrol prices. Certainly good news for consumers – we now just have to wait to see how long it lasts, with key oil producing countries, such as Russia taking a big hit. The following articles consider this story.
Articles
Supermarkets cut fuel prices again The Telegraph, Nick Collins (6/11/14)
Petrol retailers urged to cut prices in line with falling oil costs The Guardian, Terry Macalister (6/11/14)
Supermarkets cut petrol prices after chancellor’s criticism Financial Times, Michael Kavanagh (6/11/14)
Governent ‘watching petrol firms’ Mail Online (6/11/14)
Our horrendous tax rates are the real reason why petrol is still so expensive The Telegraph, Allister Heath (6/11/14)
Osborne ‘expects’ fuel price drop after fall in oil price BBC News (6/11/14)
Danny Alexander tells fuel suppliers to pass on oil price cuts to drivers The Telegraph, Peter Dominiczak (5/11/14)
Further UK fuel cuts expected as pound strengthens The Scotsman, Alastair Dalton (6/11/14)
Data
Spot oil prices Energy Information Administration
Weekly European Brent Spot Price Energy Information Administration (Note: you can also select daily, monthly or annual.)
Annual Statistical Bulletin OPEC
Questions
- Using a supply and demand diagram, illustrate the impact that a fall in the price of oil should have on the price of petrol.
- What is the impact of a tax on petrol?
- Why is petrol a market that is so heavily taxed? You should think about the incidence of taxation in your answer.
- Why does the strength of the pound have an impact on petrol prices in the UK and how much of the oil price is passed onto customers at the pumps?
- Does the structure of the supermarket industry help customers when it comes to the price of petrol? Explain your answer.
- Militant action in some key oil producing countries has caused fears of oil disruption. Why is that oil prices don’t reflect these very big concerns?
One of the key battle grounds at the next General Election is undoubtedly going to be immigration. A topic that is very closely related to EU membership and what can be done to limit the number of people coming to the UK. One side of the argument is that immigrants coming into the UK boost growth and add to the strength of the economy. The other side is that once in the UK, immigrants don’t move into work and end up taking more from the welfare state than they give to it through taxation.
A new report produced by University College London’s Centre for Research and Analysis of Migration has found that the effect on the UK economy of immigrants from the 10 countries that joined the EU from 2004 has been positive. In the years until 2011, it has been found that these immigrants contributed £4.96 billion more in taxes than they took out in benefits and use of public services. Christian Dustmann, one of the authors of this report said:
“Our new analysis draws a positive picture of the overall fiscal contribution made by recent immigrant cohorts, particularly of immigrants arriving from the EU … European immigrants, particularly, both from the new accession countries and the rest of the European Union, make the most substantial contributions … This is mainly down to their higher average labour market participation compared with natives and their lower receipt of welfare benefits.”
The report also found that in the 11 years to 2011, migrants from these 10 EU countries were 43 per cent less likely than native Britons to receive benefits or tax credits, and 7 per cent less likely to live in social housing. This type of data suggests a positive overall contribution from EU immigration. However, critics have said that it doesn’t paint an accurate picture. Sir Andrew Green, Chairman of Migration Watch commented on the choice of dates, saying:
“If you take all EU migration including those who arrived before 2001 what you find is this: you find by the end of the period they are making a negative contribution and increasingly so … And the reason is that if you take a group of people while they’re young fit and healthy they’re not going to be very expensive but if you take them over a longer period they will be.”
However, the report is not all positive about the effects of immigration. When considering the impact on the economy of migrants from outside of the EEA, the picture is quite different. Over the past 17 years, immigration has cost the UK economy approximately £120bn, through migrant’s greater consumption of public benefits, such as the NHS, compared to their contributions through taxation. The debate is likely to continue and this report will certainly be used by both sides of the argument as evidence that (a) no change in immigration policy is needed and (b) a major change is needed to immigration policy. The following articles consider this report.
Report
The Fiscal effects of immigration to the UK The Economic Journal, University College London’s Centre for Research and Analysis of Migration, Christian Dustmann and Tommaso Frattini (November 2014)
Articles
Immigration from outside Europe ‘cost £120 billion’ The Telegraph, David Barrett (5/11/14)
New EU members add £5bn to UK says Research BBC News (5/11/14)
UK gains £20bn from European migrants, UCL economists reveal The Guardian, Alan Travis (5/11/14)
EU immigrant tax gain revealed Mail Online (5/11/14)
Immigration question still open BBC News, Robert Peston (5/11/14)
EU migrants pay £20bn more in taxes than they receive Financial Times, Helen Warrell (5/11/14)
Questions
- Why is immigration such a political topic?
- How are UK labour markets be affected by immigration? Use a demand and supply diagram to illustrate the effect.
- Based on your answer to question 2, explain why some people are concerned about the impact of immigration on UK jobs.
- What is the economic argument in favour of allowing immigration to continue?
- What policy changes could be recommended to restrict the levels of immigration from outside the EEA, but to continue to allow immigration from EU countries?
- If EU migrants are well educated, does that have a positive or negative impact on UK workers, finances and the economy?
An investigation by the International Consortium of Investigative Journalists has revealed how more than 1000 businesses from 340 major companies from around the world have used Luxembourg as a base for avoiding huge amounts of tax. Many of the companies are household names, such as Ikea, FedEx, Apple, Pepsi, Coca Cola, Dyson, Amazon, Fiat, Google, Accenture, Burberry, Procter & Gamble, Heinz, JP Morgan, Caterpillar, Deutsche Bank and Starbucks. Through complicated systems of ‘advanced tax agreements’ (ATAs), negotiated with the Luxembourg authorities via accountants PricewaterhouseCoopers (PwC), companies have used various methods of avoiding tax.
So what methods do Luxembourg and these multinational companies use to reduce the companies’ tax bills? There are three main methods. All involve having a subsidiary based in Luxembourg: often little more than a small office with one employee, a telephone and a bank account. All involve varieties of transfer pricing: setting prices that the company charges itself in transactions between a subsidiary in Luxembourg and divisions in other countrries.
Tax loopholes offered by tax havens, such as Luxembourg, the Cayman Islands and the Channel Islands, are denying exchequers around the world vast sums. Not surprisingly, countries, especially those with large deficits, are concerned to address the issue of tax avoidance by multinationals. This is one item on the agenda of the G20 meeting in Brisbane from the 12 to 16 November 2014.
